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Belgium: Clarity after deadlock

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After more than a year of political deadlock, Belgium’s new government has pensions in its sights. Christine Senior reports

Proposed changes to pensions have brought protestors to the streets in Belgium. Just two weeks after the swearing-in of the new prime minister, Elio di Rupo, after a 541 day political deadlock, the incoming administration faced strike action over its pension reforms introduced to cut the budget deficit.

The cause of the unrest was the government’s plans to reduce early retirement by introducing penalties for retiring before the official age of 65. The effective retirement date in Belgium is 59 and the government needs to persuade more people to work longer. The new administration has worked fast to put together an austerity package which will increase tax on retirement funds for those retiring at 60 from 16.5% to 20%, and for those retiring at 62 to 18%. Tax relief on pension savings is also to be reduced. But, the measures still need to get parliamentary approval which is uncertain. This leaves pension funds in a difficult position.

Edwin Meysmans, managing director of the KBC pension fund says: “Today, we are paying pensions but people don’t know how much tax they will have to pay. We are already doing a tax deduction of 16.5% when we pay, but we are telling pensioners they may have to pay another 3.5% later in the year. People are asking: should I wait to 2013 to retire or should I do it now? And we can’t answer.”

Final figures for asset allocations for 2011 are not yet available from Mercer but if the trend at end of the third quarter continues, which seems likely, equity allocations will have continued to shrink, with a corresponding rise in bond allocations. Between December 2010 and end of September 2011, equities shrank from 46.8% to 40.6% while bond allocations grew from 44.9% to 49%. But market value changes without corresponding portfolio rebalancing, rather than active decisions by pension funds to change allocations, could be partly responsible.

The biggest changes apply to bond portfolios with yield the driving force. The euro-zone sovereign debt crisis has forced funds to reassess their allocations. The dilemma is that debt of the highly rated core European nations - Germany, Finland, Luxembourg, the Netherlands - is low yielding, while the bonds of the peripheral nations of Greece, Ireland and Portugal carry too much default risk. This is forcing a shift away from sovereign to corporate debt.

And that shift can be substantial. Kristof Woutters, head of pension solutions at Dexia Asset Management, says: “At a round table in October, many pension funds told us that within the fixed income part of their portfolios they are switching from a majority in government bonds to prioritising corporate bonds, many having allocations of 60, 70 or even 80% in corporate bonds. The reason is the government debt crisis.”

Hugo Lasat, partner at Petercam, has also seen increased interest in corporate fixed income, as well as in high yield debt among certain investors, although he is uncertain whether this purely down to the government debt crisis, or the desire to build an efficient portfolio.

“We get a lot of questions from pension schemes about corporate fixed income, and to a lesser extent high yield. These offer a risk premium for a well diversified portfolio which is attractive in this lower yielding environment. On a board of directors you have to be courageous to propose implementing a small part of the portfolio to an asset class like high yield. It may be offering 600-700bps spreads, but for the board there is trepidation.”

Another change, according to Mercer principal Thierry Laloux, is that pension funds are more prescriptive in the mandates they give to managers.

“Funds are much more specific in the way they set the ground rules to the asset manager. They don’t just say you need to invest 60% in bonds, they put specifications on the type of bonds to be included, the split between corporate and government bonds, down to the benchmark to be used and the investments to be excluded.”

Laloux says this new strictness is due to managers’ attitude to risk and new instructions from the regulator.

“This is in line with two things, one is the desire from pension funds to be more prudent and also the control authority. The Financial Services and Market Authority (FSMA) published last year some recommendation on the statement of investment principles, as well as indicating the principles to follow, with a strong emphasis on risk management.”

The funding level of pension plans is not an issue in Belgium. The majority are well funded, but the overall position hides a worrying concern. Under the prudential regulation which governs the long term funding position there is a certain amount of flexibility allowed to pension schemes on the discount rate used to calculate liabilities. This can be based on market interest rates, or the expected return on the investment portfolio. Some use conservative discount rates, while others are more aggressive. The result is that the average figure of 5.1% is significantly higher than the rate used elsewhere in Europe. Apparently, comfortable funding levels may be misleading.

Woutters says: “If you apply the same discount rates as in other countries you would see the average funding level is much lower than what is currently published. It’s a problem but most people don’t see it, don’t realise how important the discount rates are in calculating the liabilities which makes it very difficult to implement advanced ALM/LDI investment strategies.”

New tighter rules at a European level through a revised IORP directive would have a big impact on Belgian pensions’ funding levels, says Woutters.

“If, there is a new pension fund directive, one of the main goals of EIOPA would be the creation of a harmonised European-wide regulatory framework. They would like pension funds to stop using unrealistic, high discount rates. With IORP II, I am sure funding levels of Belgium pension funds will start decreasing, not linked to investment returns, but to the way liabilities need to be calculated.”

But at Aon Hewitt, retirement practice leader Thierry Verkest, who works with multinationals to set up Belgium-based pan-European pension funds, sees the flexibility in governance, funding and investments as positives. He argues that the pensions board has the flexibility to define liabilities according to what is most prudent for their scheme, and it can vary according to the sponsor’s strength.

“The board of a pension fund that has confidence working with a strong sponsor does not need to overestimate the liabilities. You don’t necessarily have that flexibility in other countries. It’s one of the reasons why multinational companies tend to come to Belgium to set up their pension fund. It’s a big advantage.”

This year could prove tough for funding levels, for those pension funds discounting liabilities based on overoptimistic expectations of returns on assets. That is, if performance this year is similar to last year.

“When we look at 2012, a lot of pension funds are funded on the basic assumption they will have a performance of almost 6%,” says Patrick Grauwels, head of institutional asset management at KBC Asset Management. “That wasn’t achieved in 2011. It will be a challenge in 2012 to have performance in line with the theoretical performance used for funding purposes.”